Q4 2023 Discover Financial Services Earnings Call
Good morning, My name is Todd and I will be your conference operator today.
Todd: At this time I would like to welcome everyone to the fourth quarter 2023 discover financial services earnings Conference call.
Todd: All lines have been placed on mute to prevent any background noise.
Todd: After the Speakers' remarks, there will be a question and answer session. If you would like to ask a question at that time. Please press star one on your telephone keypad.
If you should need operator assistance, Please press star zero.
Speaker Change: Thank you I will.
Speaker Change: Now I'll turn the call over to Mr. Eric What's your strip senior Vice President of corporate strategy and Investor Relations. Please go ahead.
Eric: Thank you and welcome to this morning's call I'll begin on slide two of our earnings presentation, which you can find in the financial section of our Investor Relations website Investor Relations Dr discover dot com.
Eric: Our discussion today contains certain forward looking statements are subject to risks and uncertainties that may cause actual results to differ materially. Please refer to our notices regarding forward looking statements that appear in our fourth quarter 2023 earnings press release and presentation. Our call. Today will include remarks from our interim CEO, John Alan and John Greene, Our Chief financial.
Eric: Yeah.
Eric: After we conclude our formal comments there'll be time for a question and answer session. During the Q&A session. We request that you ask one question followed by one follow up question. After your follow up question. Please return to the queue now it's my pleasure to turn the call over to John Thank you, Eric and thanks to our listeners for joining today's call.
John: 2023 was a year of significant change for discover and we believe the actions we've taken position the company to continue driving strong long term performance.
John: When I stepped into the interim CEO role I had three priorities.
John: Top priority was to advance our culture of compliance we've made meaningful strides in our corporate governance and risk management capabilities that said. This is a journey that will take time and continued investments over the coming years to further enhance our compliance and risk management capabilities.
John: My second priority is to continue delivering a great customer experience at every touch point, which we do by providing our customer with award winning service and products I'd like to thank our 20000 employees for delivering a great customer experience to help our customers achieve a brighter financial future.
John: In 2023, we were recognized for the first time as one of Fortune 100 best companies to work for.
John: This award ads for accolade for working parents women and people with disabilities and members of the LGBTQ plus community and we're proud to be an inclusive workplace. My third priority is to sustain our strong financial performance. We reported net income of $2 9 billion for full year 2023.
John: And earnings per share of $11 26.
John: This makes 2023, the third best year for EPS performance in our history in delivering these results. We achieved several important milestones we exceeded 100 billion in card receivables grew deposits by 21% year over year successfully launched our cashback debit account on a NAV.
John: <unk> scale.
John: We announced our intent to exit the private student lending business on.
John: On December the allowance, we announced a new leadership and we're excited to have Michael roads, joining us for our incoming Chief Executive Officer.
John: Michael has experienced leader with a deep background in the financial services industry.
John: His manage all aspects of our consumer banking business with deep experience in the credit card space payments online and mobile banking and served as group head of innovation and technology to the appointment marks the conclusion of a rigorous search process and we look forward to Michael's arrival.
When Michael arrives our returned in my prior role on discovers board of directors in conclusion I am proud of the progress we made in 2023, our integrated digital banking model resilient financial performance and maturing risk management and compliance capabilities position discover well for 2024 and beyond.
John: That I will now turn the call over to John Greene, who will review our fourth quarter 2023 financial results in more detail and provide some perspective on 2024. Thank you John and good morning, everyone I'll start with our summary financial results on slide four.
John: In the quarter, we reported net income of $388 million down from just over $1 billion in the prior year quarter. There are three broad trends to call out.
John: <unk>.
John: We grew revenue, 13%, reflecting 15% loan growth, partially offset by modest NIM compression.
John: Provision expense grew by $1 billion charge offs increased but landed at the low end of our expected range strong loan growth and higher delinquency drove the increase to our reserve balance finally expenses increased 19% year over year, reflecting investments in compliance.
John: And risk management.
John: <unk> four customer remediation and higher marketing expense to support our national Cashback debit campaign, we will get into the details of these topics in the following pages turning to slide five our net interest margin ended the quarter at 10, 98%.
John: <unk> 29 basis points from the prior year and up three basis points sequentially declined from the prior year quarter was driven by higher funding costs and higher interest charge offs, which were partially offset by higher prime rate and increases in revolving balances.
For the full year net interest margin was 11.07% up three basis points from the prior year. This margin performance reflects the improvement in our funding mix over the past several years.
John: A reduced level of balance transfer and promotional balances as we tightened underwriting receivable growth remained robust card increased 13% year over year due to contributions from their prior year, new account growth and a lower payment rate that.
John: Payment rate declined about 110 basis points from the sequential quarter and is now 100 basis points above 2019 levels.
John: Overall, new account growth declined 9% as a result of credit actions.
John: Sales were up 3% compared to the prior year quarter personal loans were up 23% driven by continued strength in originations and lower payment rate versus the prior year.
John: Student loans were flat year over year as we prepare for a potential sale of this portfolio, we will cease accepting applications for new loans on February one our deposit business delivered outstanding performance in a challenging year.
John: Average deposits were up 21% year over year, and 4% sequentially, our direct to consumer balances grew $3 billion in the period and $14 billion in the year looking at other revenue on slide six non interest income increased $74 million or 11%.
John: Was primarily driven by an increase in loan fee income higher transaction processing revenue from our pulse business and higher net discount and interchange revenue high rewards rate was 137 basis points in the period and a 140 basis points for the full year 2023.
John: A decrease of one basis points on a full year basis.
John: The decline reflects lower cashback match from slowing new account growth and our active management of our 5% categories moving to expenses on slide seven total operating expenses were up $280 million or 19% year over year and up 22%.
John: From the prior quarter looking at our major expense categories compensation cost increased $73 million or 13% from higher headcount marketing expenses increased $59 million were 19% professional fees were up driven by continued investment in compliance and risk.
John: Management capabilities, while other expense reflects a reserve for customer remediation moving to credit performance on slide eight <unk>.
John: Total net charge offs were $4, one, 1% 198 basis points higher than the prior year and up 59 basis points from the prior quarter in card as anticipated delinquency formation is slowing as more recent vintages season, we added a slide detailing some of the drivers of.
Our credit performance in the appendix to the earnings presentation.
John: Turning to the allowance for credit losses on slide nine.
John: This quarter, we increased our reserves by $618 million and our reserve rate increased by 17 basis points to just over seven 2% the.
John: The increase in reserves was driven by receivable growth and higher near term loss content from higher delinquencies under Cecil reserve levels increase as you approach peak losses, we expect our losses to rise through the mid year, and then plateau through the back half with some seasonal variation.
John: In terms of our macroeconomic outlook, our view of unemployment was relatively unchanged. While household net worth projections increase slightly these changes provided a small benefit to reserves looking at slide 10, our.
John: Our common equity tier one for the period was 11, 3%.
John: Sequential decline of 30 basis points was driven largely by asset growth, we declared a quarterly cash dividend of <unk> 70 per share of common stock.
John: Concluding on slide 11, with our perspective on 2024. These exclude the impact of a potential student loan portfolio sale. We expect end of period loan growth to be relatively flat, while average loan growth will be up modestly year over year, we expect full year net interest.
John: And to be 10, five to 10, 8%. We're currently anticipating for rate cuts of 25 basis points. In 2024. This is two more rate cuts than in our forecast in December each cut reduces NIM by approximately five basis points subject to a deposit beta.
John: We expect total operating expenses to increase by a mid single digit percent. This contemplates our expectation for compliance related costs to be approximately $500 million this year.
John: Total expenses may increase of incremental resources, where remediation is required.
John: We expect net charge offs in the range of $4 nine to five 3%.
John: Finally regarding capital return.
John: We will participate in this year's CCAR process and believe the results should help inform our view of capital management for 2024 importantly.
John: Importantly, our capital management priorities have not changed.
John: <unk> remains centered on supporting organic growth and returning capital to shareholders.
John: To summarize we continue to generate solid financial results.
John: For 2024, we will continue to advance our compliance and risk management capabilities and investing in efforts to drive sustainable long term value creation.
John: With that I'll turn the call back to our operator to open the line for Q.
John: At this time, if you would like to ask a question. Please press star one on your telephone keypad if.
If you wish to remove yourself from the queue you may do so by pressing star two.
John: We remind you to please pickup your handset for optimal sound quality.
John: Again, Thats star one to ask a question.
Speaker Change: Our first question will come from Rick Shane with J P. Morgan. Please go ahead.
Rick Shane: Good morning to everybody and thanks for taking my question.
Excuse me I'm, a little under the weather today, so I apologize.
Rick Shane: <unk> loan growth expectations is that organic loan growth or is that net of the portfolio of sale of the student loans.
Speaker Change: Hey, Rick John John Greene here that is organic loan growth. So all of the all of the guidance excluded the impact of a potential student loan asset sale.
Speaker Change: Okay. That's it thank you guys.
Speaker Change: Thank you. Our next question will come from Moshe Orenbuch with TD Cowen.
Moshe Ari Orenbuch: Great. Thanks, John maybe just to follow up on Rick's question, I mean, given the strong growth that you're currently seeing.
Moshe Ari Orenbuch: The personal loan business.
Moshe Ari Orenbuch: And the fact that youre still adding accounts, albeit at a lower level in the credit card business.
Moshe Ari Orenbuch: <unk> mentioned kind of lower college transfers, but.
Moshe Ari Orenbuch: And what's going on can you talk about kind of deconstruct that loan growth expectation for us a little bit.
Speaker Change: Sure sure sure. Thanks Moshe.
Speaker Change: So.
Speaker Change: The components of loan growth.
Speaker Change: <unk>.
Speaker Change: New account generation.
Speaker Change: Rate trend and so what.
What we're anticipating for sales given.
Speaker Change: Given the slowdown through.
Through 2023 in terms of sales, although we did have a pretty strong holiday season.
Speaker Change: Is that sales will be relatively flat year over year.
Speaker Change: New account generation relative to last year, certainly down but overall positive.
Speaker Change: New account growth.
Speaker Change: And payment rate.
Speaker Change: What we've tried to do here is.
Speaker Change: Can a derisked forecast so we assume that 100 basis points of payment rate, that's elevated versus 2019 will remain elevated.
Speaker Change: So those those three components.
Speaker Change: Reflect.
Speaker Change: Ill end up coming in and reflecting on our projections now.
Speaker Change: Loan growth could actually come in higher.
Speaker Change: If payment rate continues to decline, but overall.
Speaker Change: Our basis for guidance loan growth net interest margin in charge offs was two to give a range and then also.
Be relatively conservative in terms of the expectations on those ranges.
Speaker Change: Great. Thanks, and maybe just as a follow up.
On the credit side I mean, you did talk.
Speaker Change: Chuck a month ago, and then mentioned again today that you expect kind of losses to peak around the middle of the year.
Speaker Change: How do we think about that performance after that peak I mean, you said kind of flattish.
Speaker Change: Yes.
Speaker Change: What's driving that why isn't that something that improves and how do we think they've got reserving in that context.
Speaker Change: Sure Yes.
Speaker Change: A couple of different components that are driving that so if you go back in time.
Speaker Change: We had about two years of.
Speaker Change: Unusually low.
Speaker Change: Charge offs and delinquencies so from the pandemic and.
Speaker Change: That process of normalization typically we'll take about the same amount of time two years.
The vintages 'twenty, one and 'twenty two are seasoning and Thats why we expect it to plateau at 23 vintage actually was relatively large but.
Speaker Change: Too early to call, whether its going to outperform our expectations, but certainly.
Speaker Change: A highly profitable vintage from.
Speaker Change: From our vantage point today. So what you are actually just seeing is a period of normalization and so my expectation is that.
Speaker Change: Charge offs will plateau, and then and beginning in 2005 I would expect those to stepped out now.
Speaker Change: You will know from this past year and the prior year, what we've tried to do in terms of the guidance is be conservative.
Speaker Change: In terms of the range and throughout 2023, we tightened we tightened the range and actually came in at the low end so.
Speaker Change: I hope is that we'll be able to do the same thing.
Speaker Change: And.
Speaker Change: 2024.
Speaker Change: Great. Thanks.
Speaker Change: Thank you. Our next question will come from Ryan Nash with Goldman Sachs.
Ryan M. Nash: Hey, good morning, everyone.
Ryan M. Nash: John.
Ryan M. Nash: Maybe dig a little bit deeper on some of the commentary you gave regarding.
Ryan M. Nash: Loan growth, maybe just focusing on the account growth.
Ryan M. Nash: The market clearly thinks there's a better chance of a soft landing right now we're seeing peers, who were talking about mid to high single digit growth and I'm. Just curious on the account growth is this more just conservative underwriting are you trying to make sure that you make more progress on risk governance and compliance before you increase growth, maybe just a little bit more color on why you're seeing such a slowdown.
Ryan M. Nash: In terms of the account growth relative to the last few years.
Speaker Change: Yes, Thanks Ryan.
Speaker Change: So our.
Speaker Change: Our approach in.
Speaker Change: In 'twenty three.
Speaker Change: Then early into 24 was that we took a look at underwriting and performance of <unk>.
Speaker Change: What I'll say buckets within our underwriting box.
Speaker Change: And.
Speaker Change: And essentially tightened and we've tightened throughout 2023.
Speaker Change: What what Youre seeing here in terms of a cow.
Speaker Change: Account growth at least projections today.
Speaker Change: As us getting back to 2018, and 19 levels as we continue to watch that 22% and 23 vintage perform and.
Speaker Change: Six months from now we may end up stepping into a little bit more aggressively but what we wanted to do certainly was led.
Speaker Change: Kind of get further confirmation that the delinquency trends that we have seen in terms of slowing rate of delinquency formation continue to persist and that the charge offs.
Speaker Change: Forecasted.
Speaker Change: Come in at or better than that our expectation. If those two factors are at play there will be an opportunity to be more aggressive in terms of new account for us.
Speaker Change: Got it and maybe as my follow up can you maybe help us understand where you stand with the student loan sale and how would you foresee that impacting the outlook as well as capital return over the next four to six quarters. Thank you.
Thanks, Ryan so.
Speaker Change: Good news so it is actually progressing to schedule so matter of fact.
Speaker Change: Last evening, we signed a servicing agreement with Nelnet to become the service area of this portfolio so that was.
Speaker Change: Great News.
Speaker Change: <unk> process and.
Speaker Change: Certainly none that show that there is a commitment to continue to.
Speaker Change: Dedicate resources and service that portfolio at a high level.
Speaker Change: The next step will be.
Speaker Change: To continue the servicing migration activities, we expect those activities will take.
Speaker Change: Around six months.
Speaker Change: Conservatively it may take a month or two longer and then.
Speaker Change: As we're doing that.
Speaker Change: Our advisor will begin to market the portfolio. So our expectations are that.
Speaker Change: It will it will sell in in the second half.
Speaker Change: And the implications for the business are as follows so theres $9 $5 billion of receivables.
Speaker Change: That equates to.
Speaker Change: Risk weighted assets of about $10 8 billion.
Speaker Change: We expect.
That will be.
Speaker Change: The exit of that will have a positive impact on net interest margin.
Speaker Change: By somewhere between 10, and 20 bps on a full year basis.
Speaker Change: Charge off rate.
Speaker Change: Could could tick up mildly.
Speaker Change: So under five bps.
Speaker Change: As of 12, 31, we had $858 million of.
Speaker Change: Our reserves, so with a successful exit.
Those reserves will do.
Speaker Change: Drop and and.
Speaker Change: <unk>.
Speaker Change: <unk> price the market will determine that but we expect it to go.
Speaker Change: Go above par.
Speaker Change: Thank you for all the color.
Speaker Change: Thank you. Our next question will come from Mihir Bhatia with Bank of America.
Mihir Bhatia: Hi, Thank you for taking my question.
Mihir Bhatia: Scott with loan growth also and.
Mihir Bhatia: I just wanted to go back to the building blocks a little bit I think you essentially said in terms of the building blocks, you're expecting payments rates to be elevated.
Mihir Bhatia: To stay up with elevated level and sales to be flat, you're also adding a call.
So I'm just.
Mihir Bhatia: I'm trying to understand.
Mihir Bhatia: But I guess, what's the bad Guy like.
Mihir Bhatia: Loan growth stay flat given.
Mihir Bhatia: If you have 15, besides just trying to understand.
Mihir Bhatia: Alright.
Mihir Bhatia: Well somebody if I'm missing I feel like I'm, just trying to understand that.
Speaker Change: Yes, So let me try to give a little bit of color that hopefully gets folks comfortable with.
Speaker Change: Yes.
Speaker Change: Our view of loan growth today.
Speaker Change: In 2023.
Speaker Change: Really really strong loan growth.
Speaker Change: Much of that was was driven both by new account growth.
Speaker Change: But also a slowing payment rate that payment rate in our assumptions.
Speaker Change: Is holding flat.
Speaker Change: And and as a result.
Speaker Change: What what we expect to see as the 2023 vintage will begin to.
Speaker Change: Kind of build in terms of assets, but there is likely going to be some impact from sales and then also as as we cycle through the 2022 vintage we're not expecting significant new balanced builds from that.
Speaker Change: Now, maybe there will be but.
Speaker Change: Overall.
Speaker Change: What we've tried to do here is reflect our view of our underwriting box today.
Speaker Change: Not not.
Speaker Change: Not reflect any potential openings of our underwriting box and the later part of 2023.
Speaker Change: And.
Speaker Change: If we deliver on loan growth.
Speaker Change: That will be fantastic.
Speaker Change: The other element that.
Speaker Change: Has come into play here as we pulled back on balance transfer some promotional balances.
Speaker Change: And the second part of 2023.
Speaker Change: We don't anticipate.
Speaker Change: Yes.
Speaker Change: Significantly increasing that level of balance transfer promotional balances now.
Speaker Change: If we do that it will certainly be accretive to loan growth as well so what what youre hearing in the guidance is that our expectation is that.
Speaker Change: There is an opportunity to deliver better but certainly.
Speaker Change: We possess.
Speaker Change: Position, both the guidance and the business to be conservative at least for the next quarter or two.
Speaker Change: Got it and then.
Speaker Change: I wanted to go back to the expenses and the reserve for customer remediation that you mentioned.
Speaker Change: This quarter can you just provide some more color on that like is that related to the motion mispricing issue. How much was resolved this quarter, where does that leave the reserve overall think about $365 million in Q I'm just trying to understand how is the estimate for the cost related to that issue changed I think you also mentioned it could be higher expenses would be higher in 'twenty four.
Speaker Change: If you need to take more reserves there.
Speaker Change: Where are we owed that investigation, just give us an update on that margin mix pricing issue too.
Speaker Change: Yes, Okay. So let me start with the with their reserve.
Speaker Change: <unk>.
Speaker Change: And the <unk>.
Speaker Change: <unk>.
Speaker Change: <unk> that we put up so that they are unrelated so the.
Speaker Change: Merchant chairing reserve, we booked 365 as a liability.
Speaker Change: That has moved.
Speaker Change: Now about $370 million, just as we've had some payments and.
Speaker Change: And other flows in through the.
Speaker Change: The interchange that we had to correct manually for.
Speaker Change: So.
Speaker Change: The progress there in terms of discussions with our merchants is positive.
Speaker Change: We don't have enough data points to make a material change to that reserve level, yet, but it's it's.
Speaker Change: <unk> My view positively.
Speaker Change: Through through.
Speaker Change: Through the end of the year and today as we speak now separately.
Speaker Change: We put up $80 million for a.
Speaker Change: As we described at our customer remediation reserve now.
Speaker Change: Some context to that as is.
Speaker Change: As part of this compliance journey, we've put in a significant number of resources to help us identify and correct issues and as we prepare.
Speaker Change: The business to continue to move forward to drive organic growth.
Speaker Change: We're getting much much better at identifying issues and we identify an issue what what we've done here is if we think there is an there is.
Speaker Change: It is appropriate to refund.
Speaker Change: Refund customer payments, we're going to do that so.
Speaker Change: We identified.
Speaker Change: A particular issue largely within <unk>.
Servicing where our student loan business.
Speaker Change: There was there was it 10 gentle impact and another business line and we continue to look.
Speaker Change: <unk> our business.
Speaker Change: But.
Speaker Change: The lion's share of that reserve relates to student loans and essentially what we're doing.
Speaker Change: <unk> is trying to position the business.
Speaker Change: And that that product for successful exit.
Speaker Change: Thank you for taking my question So I'll go back.
Speaker Change: Right.
Speaker Change: Thank you. Our next question will come from Sanjay <unk> with <unk>.
Sanjay: Thanks, Good morning.
Sanjay: Sorry, Multipart question on the same topic and then a follow up.
Can you update us John on the progress made with the regulatory agencies I think that was sort of alluded to in the previous question, but maybe just the firmness around capital return post CCAR, what exactly happens to.
Sanjay: The CFPB consent order when the loan servicing is transferred and then just curious the the loan growth expectations was that any part driven by any regulatory related matters.
Sanjay: Yes. This is John I'll take part of that and John Greene will take the capital part, but I would tell you is over the last 18 months or so we've made significant progress improving our risk management and compliance capabilities and we've increased our investments on risk and compliance in 2022 to 2023 up to about a 500 million.
John T. Greene: <unk> level and as John mentioned earlier, we think expense growth and that'll be in the mid single digits in line with other guidance. We've given we've made improvements in risk and compliance, but we still have quite a bit of work to do one thing I'd point out the FDIC consent order, which we did get it was made public.
John T. Greene: Does not include the Misclassification issue in that scope of work, we're working closely with our regulators on that topic I really don't have anything further to add on that topic at this point in time.
John T. Greene: Okay.
John T. Greene: Sanjay.
Speaker Change: I feel like your question is a five part question, but what I will do us.
Speaker Change: Sorry.
Speaker Change: We'll do our best to answer it so the loan growth.
Speaker Change: Aspect that you asked.
Speaker Change: It is completely unrelated to any regulatory issues. So so nothing nothing that connect on that point.
Speaker Change: In terms of.
Speaker Change: Capital return.
Speaker Change: Our commitment to <unk>.
Speaker Change: Capital return and capital allocation have not changed.
Speaker Change: First two.
Speaker Change: Invest in profitable organic growth and second to return excess capital to shareholders.
Speaker Change: As we.
Speaker Change: As we.
Speaker Change: Kind of progressed through the fourth quarter, we remained on pause with our buybacks.
Speaker Change: Given we've got a new CEO coming in.
Speaker Change: We are contending with a number of different compliance and risk management matters.
Speaker Change: Tearing reserve, we don't have any any any feedback from our regulators.
Speaker Change: That point, we decided that it would be most appropriate to remain conservative in terms of our guidance related to buybacks.
Speaker Change: We.
Speaker Change: We will go through CCAR. So as I said in my prepared remarks that will form a view of capital under under significant stress as it always does and then we're going to have the exit.
Speaker Change: Hopefully the exit from the student loan business, which it will.
Speaker Change: Provide.
Speaker Change: Free up at least $2 billion worth of capital.
Speaker Change: <unk>.
Speaker Change: What you are hearing here hopefully as is.
Speaker Change: Some indications that one we're committed to returning excess capital to shareholders too that there will be excess capital generated and available and three we are going to go through a diligence process.
Speaker Change: Internally share it with our board.
Speaker Change: Then.
Speaker Change: Take take the board's direction in terms of buybacks.
Speaker Change: The consent order.
Speaker Change: And.
Speaker Change: With the loan servicing like does that move yes.
Speaker Change: Oh, yes, yes, yes.
Speaker Change: As part of <unk>.
Speaker Change: Yes, so that debt.
It remains in effect.
Speaker Change: And our our chosen provider Nelnet is fully aware of the consent order requirements in terms of.
Kind of servicing excellence and they were chosen because they've got a track record in terms of being able to kind of service portfolio such as this and.
Speaker Change: Dave dedicated both technology and resources to ensure a seamless transition.
Speaker Change: Okay. Then my follow up question is sorry to my five part question is the reserve rate Moshe sort of asked about a little bit, but how should we think about that reserve rate.
Speaker Change: Migrating over the course of the year given that the charge off rate plateaus does the reserve rates start coming down and where does it come down to in a normal environment I'm just trying to think about how we model that because that's really important.
Speaker Change: Yes, yes.
Speaker Change: Thanks for that we are hoping that that question would come out so.
Speaker Change: <unk>.
Speaker Change: Let me talk about the reserves for the quarter and then then I'll.
To give some perspective on.
Speaker Change: 24.
Speaker Change: What could potentially happen there. So we grew receivables in the quarter $5 7 billion now some of that was transact or balances.
Speaker Change: Our reserve life.
Speaker Change: But.
Speaker Change: One thing that we've been consistent on in terms of our communication.
Speaker Change: That.
Speaker Change: As as we approach peak losses reserve levels increase and what we've said previously is typically we hit the highest reserve rate level, one to two quarters before peak losses. So that's.
Speaker Change: That's the path we're on.
Speaker Change: Let me provide some details on some assumptions that were used to.
Speaker Change: To set the reserve levels. This year at year end, and then I'll give a perspective on what.
Speaker Change: What we.
Speaker Change: What could happen in 2024.
Speaker Change: So the macro is relatively benign so unemployment levels. We ended the year at 337.
Speaker Change: We've assumed as unemployment level of four point to a mild increase household net worth mild decrease savings rate mild increase and GDP to be in 2020 for it it would be about one 3% so.
Speaker Change: Relatively conservative but not.
Speaker Change: Not overly optimistic set.
Speaker Change: Up assumptions now.
Speaker Change: What.
What will come into play in 2024.
Speaker Change: Obviously, the macros, which will continue to be important in our portfolio performance and by the way. It is it is tracking to our expectations with month over month delinquency formation.
Speaker Change: Declining.
Speaker Change: The credit quality of the book remains relatively consistent with.
Speaker Change: What we've done historically.
Speaker Change: So.
Speaker Change: Our expectation is that <unk>.
Speaker Change: Assuming the macros remain consistent.
Speaker Change: And.
Speaker Change: And the portfolio performance remains to our expectation that there will be some level of opportunity to reduce the reserve rate.
Speaker Change: 2024, now that's subject to significant amount of governance, and we're going to we're going to make sure that we comply with our internal processes and generally accepted accounting principles. So theyre my caveat, but.
Speaker Change: There's a lot there's a lot of things that are different.
Speaker Change: Today than day, one so.
Speaker Change: The step down will be.
Speaker Change: Aligned with those points I just mentioned.
Speaker Change: Okay, great. Thank you very much.
Speaker Change: Thank you. Our next question will come from Bill <unk> with Wolfe Research. Please go ahead.
Bill: Thank you.
Bill: Good morning, and thanks for taking my questions. John I wanted to follow up on your credit commentary given that it is such an important area of focus for investors.
Been saying all along that you didn't move down the credit spectrum.
But the concern for many investors had been that other card issuers also experienced outsized growth as we emerge from Covid.
Bill: They had also experienced some normalization headwinds, but they were now starting to see delinquency.
Bill: We should start to rollover as discovers DQ rate formations as recently as prior months Dave.
Bill: Data showed that.
Bill: Formations remained on it up until the right trajectory.
Bill: So I guess the question is does the new disclosure on slide 14 confirm that your delinquency rate formations R&D now also starting to rollover.
Bill: And if so.
Bill: Does that really just reinforce your confidence that we could see peak Ncos hit in 2024, all else equal.
Bill: Yes.
Speaker Change: Thanks for the question Bill so.
Speaker Change: Just to give you kind of the benefit of some data here.
Speaker Change: From September September through December this year so the.
Speaker Change: The.
Speaker Change: 30, plus delinquencies.
Speaker Change: Have declined month over month so in.
In September.
Speaker Change: We peaked at it and increase month over month of 26 bps.
Speaker Change: What we said in the fourth quarter as we expected that to decline or.
Speaker Change: October.
Speaker Change: Formation increased 20 bps, so so relative to decline to the prior months November 15 bps December 11 bps.
Speaker Change: Our expectation is.
Speaker Change: <unk>.
Speaker Change: That will.
Speaker Change: Continued to decline.
Speaker Change: Where it becomes negative we're not going to get into that because it will be subject to a number of different things, including kind of our origination path.
Speaker Change: And broad macro so.
Speaker Change: To get to the essence of your question, we do have a level of confidence regarding kind of what's happening in the portfolio in that trend.
Speaker Change: <unk>.
Speaker Change: As we progress.
Speaker Change: 2024 that will be reflected in hopefully tightening guidance.
Speaker Change: And then also tightening guidance to the lower end.
Speaker Change: And then also.
Speaker Change: Hopefully.
Speaker Change: The reserve rate changes.
Speaker Change: That's helpful. Thank you and following up on your expense commentary I believe you said that.
Speaker Change: Spencers may need to increase further potentially.
Speaker Change: Potentially maybe if you could frame.
Speaker Change: The possibility of there being.
Speaker Change: What.
Would view as another step function higher from here.
Speaker Change: Or how.
Speaker Change: How should we think about the risk of further increase in expenses.
Speaker Change: How are we.
Speaker Change: How should we think about your sustainable long term efficiency ratio.
Speaker Change: As we look at historically at discover has been very very much had lowest efficiency ratio in the industry.
Speaker Change: To what extent is that still something that we can expect.
Speaker Change: Okay. Thanks, Thanks, Bill so.
Bill: Our expectation is that.
Bill: The long term efficiency ratio will be sub sub 40%. So there is still.
Bill: There is still a view that that that that will happen.
Bill: The reason we put.
Bill: What I'll call has the caveat in the 'twenty 'twenty four expense guidance was.
Bill: Number of different institutions when they have been on this compliance and risk management journey.
Bill: Have not been able to call what.
Bill: What the actual compliance and risk management spend would be.
Bill: We had that remediation reserve in the fourth quarter.
Bill: There were some indications that we might have to put something up for that but we didn't know.
Bill: Still some level of unknowns unknowns and wanted to make sure we're clear to that.
Bill: People listening to this call that that there is some level of risk too.
Bill: Sure.
To the expense guidance now that said, 5% on our expense base is a significant amount of dollars. We feel like we have nearly a full complement of resources around risk and compliance today, which is good news our issues management capabilities significantly improve.
Bill: <unk>.
Bill: Our our path to.
Bill: Improving overall governance is certainly on the right trajectory. So those factors give me confidence that we're not going to have a huge surprise, but.
Bill: Maybe there could be just.
Bill: We just don't have enough certainty given where we are on our compliance journey now the rest of the cost base.
Bill: There's a couple of things to keep in mind here. So right today, we have nearly 3000 resources dedicated that risk and compliance management.
Bill: Significant amount of those resources are dedicated to issues related to student loan servicing.
Bill: With a successful exit and transfer it will give us an opportunity to scrutinize their cost base and a different different way.
Bill: So thats certainly on.
Bill: The list of planned activities.
For the second quarter third quarter, and hopefully we begin some execution.
Bill: In the fourth quarter so.
Bill: Overall, I feel I feel comfortable with the expense guidance that we've provided.
Bill: <unk>.
Bill: We're going to we're going to do our best to make sure that every dollar we spend is wise.
Bill: The shareholders get the benefit.
Bill: From that.
Speaker Change: Very helpful. Thank you for taking my questions.
Speaker Change: Youre welcome Bill.
Speaker Change: Okay.
Speaker Change: Thank you. Our next question will come from John Kerry with Evercore ISI.
John Kerry: Good morning.
John Kerry: Regarding the.
John Kerry: The new $80 million remediation charge.
John Kerry: Did.
John Kerry: And all of the remediation relate to the student loan business, specifically and was that in part tied also to the.
John Kerry: July 22 disclosure around the student loan issues that surfaced, then and did any of that $80 million relates to the other business that your point that you mentioned.
Speaker Change: <unk> had a tangential impact and what was that business. Thanks.
Speaker Change: So.
Speaker Change: The $80 million was related to servicing issues. The lion's share of that significant share of that was related to student loans.
Speaker Change: There was.
Speaker Change: A small amount that we put up.
Speaker Change: Related to personal loans upon reviewing that.
Speaker Change: There may be an opportunity to.
Speaker Change: Released released at reserve very small though.
Speaker Change: The.
Speaker Change: $80 million.
Speaker Change: <unk> connected to the issues that we discussed in July.
Speaker Change: So.
Speaker Change: What I tried to do is provide as much context as I could so.
Speaker Change: We we've dedicated a number of resources to identifying issues to help us.
Speaker Change: On this on this consumer compliance journey as.
Speaker Change: As with any company as you dedicate resources they come up to speed they are going to get more effective at identifying issues and correcting issues. This this is symptomatic.
Speaker Change: At progress. So we've got folks that are coming through every every single bit of our business to make sure. We're.
Speaker Change: We're executing consumer compliance at a high level and issue was found.
Speaker Change: Ross functional team reviewed it and we made an election that we are going to.
Speaker Change: Our crew something at year end to cover potential remediation payments.
Speaker Change: Okay, and just related to that.
Speaker Change: <unk>.
So this is a newer issue versus what was <unk>.
Speaker Change: <unk> discussed in July and it could also newer versus what is in your existing consent order tied to student loans.
Speaker Change: Yes so.
Speaker Change: What we what we disclosed in July was.
Speaker Change: A broad program around.
Speaker Change: Risk and compliance management activities.
Speaker Change: The specifics of the particular issues.
Speaker Change: Werent discussed in any details.
Speaker Change: And what I.
Speaker Change: What I've shared with you right now is probably as much information as I am going to share at this point so.
Speaker Change: But the takeaway should be is that.
Speaker Change: We're we're progressing on the risk and compliance management activities, we're getting better at identifying issues. When we find an issue we're going to we're going to deal with it.
Speaker Change: We found an issue.
Speaker Change: We've put up a reserve for that issue.
And we're going to work through further details on it in order to ensure that.
Consumer consult consumer compliance.
Speaker Change: <unk>.
Speaker Change: Is where we want it to be.
Speaker Change: So with that.
I think I'll probably close this.
Speaker Change: This particular.
Speaker Change: Item out if you don't mind.
Speaker Change: No. That's fine. Thank you for that and my last name. It's a very quick one on the loan growth guidance.
Speaker Change: The average.
Speaker Change: <unk> for 2000 were up modestly can you help maybe quantify the up modestly.
If you could maybe help frame it.
Speaker Change: So.
Speaker Change: 5% to 6%.
Speaker Change: On average.
Speaker Change: Okay, great. Thanks, Sean.
Speaker Change: Thank you. Our next question comes from Don <unk> with Wells Fargo.
Speaker Change: John.
Don: It's good to see the delinquency formation showing some progress can you talk about later stage delinquency rates I mean, they seem like they are still going up on a year over year basis like Howard cure rates I'm still trying to get my arms around this like potentially 5% NCL rate. It just seems high for discover.
Yes.
Speaker Change: Yes, the later stage buckets.
Speaker Change: Or kind of modestly improving.
Speaker Change: So were seeing improvements across every bucket.
The first bucket is really the key one and then as you get into later and later buckets.
Speaker Change: <unk>.
Speaker Change: The ability to cure just becomes more challenging because.
Speaker Change: This situation that consumers in but.
Speaker Change: We are seeing can mild improvements there. So that also is encouraging.
Okay.
Speaker Change: 'twenty three vintage can you talk a little bit about what your early read is on that.
Speaker Change: Yeah.
Speaker Change: The net of it is that its early so.
Speaker Change: Yeah.
Speaker Change: It's performing.
Speaker Change: Profitably and we're going to continue to keep our eye on it.
Speaker Change: So does that mean.
Speaker Change: It's not really trending about well relative to your expectations or is it kind of in line no I didn't say that.
Speaker Change: It's just it's early.
Speaker Change: <unk>.
Speaker Change: It is performing generally.
Speaker Change: In line with expectations.
Speaker Change: Okay. Thanks.
Speaker Change: Thank you we'll take our next question from Jeff Adelson with Morgan Stanley.
Jeff Adelson: Hi, Thanks for taking my questions.
Jeff Adelson: John I, just wanted to kind of follow up on the charge off guide I know you've mentioned that you're hopeful this should come in at the low end could you could you maybe just dive into what would take us to the low versus the high end here.
John: If this delinquency formation slowing continues throughout the year is that kind of what's embedded in your expectation at getting at the low end here.
Speaker Change: Yes. Thank you.
Yes so.
Speaker Change: <unk>.
Speaker Change: Our baseline is that it's going to come in at the low end.
Speaker Change: Now.
Speaker Change: I shared.
The information in terms of the macros that.
Speaker Change: That we use for our reserves pretty consistent in terms of.
Speaker Change: What we used for our what I'll say the second half view.
Speaker Change: Charge offs so.
Speaker Change: What could make that worse certainly.
Speaker Change: A change to the macros.
Speaker Change: Some servicing issues, which high.
Speaker Change: Highly unlikely.
Or.
Speaker Change: Miss in terms of forecasting.
Speaker Change: I am comfortable.
Speaker Change: With our forecasting team.
Speaker Change: I am comfortable with our servicing team and we've got a number of programs and we dedicated.
Speaker Change: Dedicated a lot of it.
Speaker Change: Lot of dollars in terms of analytics in terms of call call frequency and the best time to call in.
Speaker Change: We've worked on our call scripts to ensure they're compliant but also effective in terms of prioritizing payments so I feel.
Speaker Change: Feel good about that so the range just reflects a level of kind of.
Speaker Change: Broad uncertainty that we're going to tighten.
Speaker Change: Got it and just as my follow up.
Speaker Change: As we think about the NIM guide this year I know you mentioned you are embedded in your expectation for rate cuts.
Speaker Change: If I think about where NIM exited the year, though.
Speaker Change: Feels like.
Speaker Change: The range of rate cards, using your five basis points for every 25. It seems like there's more rate cut that's embedded in there can you maybe just help us understand the drivers is.
There may be a little bit more.
Speaker Change: Interest accrual reversal going on and maybe help us understand what you're assuming in deposit betas on the way down.
Speaker Change: Is it going to be a little bit slower than what we've seen in the last four rate cuts on the way up.
Speaker Change: Yes. So good question so let.
Speaker Change: Let me start off with 2023, and then the fourth quarter of 2023, so as a business.
Speaker Change: My view is great execution in terms of being able to kind of.
Speaker Change: Manage net interest margin so year over year, we're up I think we're an outlier and that's from that standpoint and in financial services.
What we saw in.
Speaker Change: Fourth quarter was.
Speaker Change: Cost of funding increased as.
Speaker Change: As lower rates Cds term out.
Speaker Change: Higher rate Cds would come in our OSA rate remains competitive.
Speaker Change: And the.
Speaker Change: The expectation on beta is that it will be in the mid seventy's in a declining rate.
Speaker Change: Yes.
Speaker Change: I hope I hope that the beta in the declining rate is higher.
Speaker Change: Also.
Speaker Change: Something that's not baked into the into the elements of the guidance, but certainly.
Speaker Change: With the exit of student loans or the proposed exit from the student loan business Thats going to throw a lot of liquidity back into the business that will give us an opportunity to be.
Speaker Change: Yes.
Speaker Change: Slightly more.
Speaker Change: Aggressive in terms of deposit pricing.
Speaker Change: That again that will be a second half activity. So.
Speaker Change: Yeah.
The four rate cuts that we put into into the baseline assumption again, two more than what we had forecasted in December.
Speaker Change: Could be as many as six which.
Speaker Change: If it is that will certainly impact.
Speaker Change: Deposit betas and.
Speaker Change: Deposit pricing and kind of sequentially net interest margin so.
Speaker Change: Yeah.
Speaker Change: <unk> here I think is appropriate.
Speaker Change: Perhaps.
Speaker Change: Little conservative than our baseline expectation is that we're going to deliver to the upper end.
Speaker Change: The guidance range.
Speaker Change: Okay. Thank you for taking my questions.
Speaker Change: Thank you we'll take our next question from Terry MA with Barclays.
Terry MA: Hey, Thanks. Good morning, maybe just wanted to touch on the loan growth guide for 'twenty for a little bit aside.
Terry MA: Aside from the balance transfers and promos how much control do you actually have on growth going from 15% loan growth to zero percent just seems like a hard pivot to me. So maybe can you just talk a little bit more about that and then my second question is just what needs to happen before you can actually grow again.
Terry MA: And is there a way to think about what that growth rate looks like as we look out towards 2025 and beyond thank you.
Speaker Change: Okay. Thanks Terry.
Speaker Change: So.
Speaker Change: I think it's important to take a look at the quarterly trends.
Speaker Change: Loan growth.
Speaker Change: Versus the total the total year because.
Speaker Change: Each quarter.
Speaker Change: What you will see is that the amount of loan growth.
Speaker Change: The decrease quarter over quarter and that was partly due to payment rate, partly due to underwriting standards.
Speaker Change: And partly due to.
Speaker Change: Kind of sales activity slowing as well.
Speaker Change: No.
Speaker Change: In 2024, we've guided to.
Speaker Change: Loan growth to be flat again payment rates 100 basis points higher than it was in 2019 that could be a positive if it if it holds where where it ended the year.
Speaker Change: <unk> not going to.
Speaker Change: Impac loan loan growth so.
Speaker Change: I feel like what we've tried to do here is put something on the table that's reasonable that doesn't reflect.
Speaker Change: A level of undue risk taking in.
Speaker Change: Time, where.
Speaker Change: Consumer behavior is actually.
Speaker Change: Changing relatively dynamically if you think back.
Speaker Change: Two and a half years ago coming out of the pandemic too.
Speaker Change: Kind of where where it is today and also the impact of inflation.
Speaker Change: It certainly all consumers, but certainly.
Speaker Change: In terms of our prime revolver consumers.
Speaker Change: The lower.
Speaker Change: The lower third of those those consumers were impacted fairly significantly by inflation. So.
Speaker Change: We do want to.
Speaker Change: Kind of watch as I said previously watch delinquency formations and in our other.
Speaker Change: Our other metrics.
Speaker Change: Before we.
Speaker Change: Press press on the gas on an.
Speaker Change: On generating.
Speaker Change: A high level of new accounts in 2024.
Speaker Change: Is there a way to think about what growth would look like before when you reaccelerate.
Speaker Change: Yes, I would go back to kind of historical growth rates on the <unk>.
Speaker Change: <unk> is typically delivered.
Speaker Change: Somewhere between three 3% and 8%.
Speaker Change: Year over year growth and then.
Speaker Change: We feel.
Speaker Change: We feel like our underwriting and.
Speaker Change: The credit and the opportunity to lend profitably.
Speaker Change: At a rate higher than that we will do that so what.
Speaker Change: An important thing for you.
Speaker Change: Our investors to remember as well.
Speaker Change: We seek to generate.
Speaker Change: High returns over the over the <unk>.
Speaker Change: Short mid and long term and that's essentially what.
Speaker Change: What this plan is seeking to deliver.
Speaker Change: So Todd I think we have time for one more please.
Thank you Sir we will go next to John Hecht with Jefferies.
John Hecht: Good morning, guys. Thanks for taking my question.
John Hecht: I know you've answered a lot of credit Suisse.
John Hecht: I apologize for one more but.
John Hecht: Your 18, and 19 charge off levels were in the low 3% range and I think we.
John Hecht: We've all kind of said that was a good.
John Hecht: Good environment, but a relatively normal environment.
John Hecht: Youre guiding toward a high relatively higher.
John Hecht: 5% charge off rate this year, despite low unemployment I know you've kind of called out the 2022 vintages something to think about there, but maybe can you can you talk about the attribution of the different is it.
John Hecht: Difference in charge off rates between that period and now.
John Hecht: I think the kind of the reason for the question just to give us some sort of level of understanding.
John Hecht: Where we are in the credit cycle and give us comfort that things will go.
John Hecht: Stabilize if not improve from here.
John Hecht: Yes.
Speaker Change: Yes happy to John So.
Speaker Change: A few points so.
Speaker Change: We're in a significantly different environment today than we were back in 2018 and 19, so we're coming off of two.
Speaker Change: Two years of abnormally low losses, so sub sub 2%.
Speaker Change: We had an incredibly high payment rate.
Speaker Change: And going back two years ago that is normalized.
Speaker Change: What we're seeing is the consumers.
Speaker Change: We had significant amount of savings those savings levels have been depleted.
Speaker Change: <unk> had a spending pattern with the consumers across the board.
Speaker Change: Was reflective reflecting kind of pent up demand and savings rates came down.
Speaker Change: Consumers.
Speaker Change: Needed to adjust their.
Speaker Change: They are spending patterns. Some did successfully some did not.
Speaker Change: And then Youre also seeing inflation, if you go back a year and a half to two years ago inflation.
Significantly outpacing wage growth.
Speaker Change: And that put certainly the lower quartile of the consumers in a significant amount of stress.
Speaker Change: And thats across across.
Speaker Change: All sectors of the economy, so not not not specifically to our prime revolver segment.
Speaker Change: And on top of that you also had in 'twenty, one and 'twenty two two very large vintages.
And.
Speaker Change: And so.
Speaker Change: You put all those together.
Speaker Change: Naturally is going to happen is you're going to have charge offs.
Speaker Change: What I'll say is peak before they normalize back to.
Speaker Change: Levels that you're accustomed to seeing from from discover so.
Speaker Change: My sense is that.
Speaker Change: Given given real wage growth.
Speaker Change: Our.
Speaker Change: Our consumers will end up.
Speaker Change: Frankly, a better spot in 'twenty, four and 'twenty five than they were in 'twenty, two and 'twenty three.
Speaker Change: And our.
Speaker Change: Our charge off forecast and reserves reflect.
Speaker Change: You that.
Speaker Change: Consumers will manage through this and delinquency formation will continue to slow so.
Speaker Change: Anyway.
Speaker Change: I hope that.
Speaker Change: I hope this color is.
Speaker Change: Is helpful.
Speaker Change: Okay, that's super helpful.
Speaker Change: Maybe could you give us a sense of the charge offs by product or maybe like the is the mix going to be consistent with historical mixes just to give us a sense from a modeling perspective.
Speaker Change: Yes, the only piece of information I'm going to give us.
Speaker Change: In the fourth quarter, we expect student loan charge offs to be significantly lower.
Speaker Change: Because we are accelerating.
Speaker Change: Thank you.
Speaker Change: Yes.
Speaker Change: Alright, well I think we're going to conclude the call. There. Thank you for joining US I know there was a few view still in Q, who we didn't get to but feel free to reach out to the IR team will be around all day and available to answer additional questions. Thanks for joining us and have a great day.
Speaker Change: And this does conclude today's discover financial services earnings Conference call. You may disconnect. Your lines at this time and have a wonderful day.
Speaker Change: Yeah.
Speaker Change: [music].
Speaker Change: Yeah.